Long live China’s slowdown

At 7.7 per cent, China’s annual GDP growth in the first quarter of this year was slower than expected. China doubters around the world were quick to pounce on the number, expressing fears of a stall or even a dreaded double dip.

But slower GDP growth is actually good for China, provided that it reflects the long-awaited structural transformation of the world’s most dynamic economy. The broad outlines of this transformation are well known — a shift from export- and investment-led growth to an economic structure that draws greater support from domestic private consumption.

Less well known is that a rebalanced China should have a slower growth rate, the first hints of which may now be evident. A rebalanced China can grow more slowly for one reason: By drawing increased support from services-led consumer demand, its new model will embrace a more labour-intensive growth recipe.

The numbers seem to bear that out. China’s services sector requires about 35 per cent more jobs per unit of GDP than manufacturing and construction, the primary drivers of the old model. That number has potentially huge implications as it means the country could grow at an annual rate in the 7 to 8 per cent range and still achieve its objectives with respect to employment and poverty reduction.

China has struggled to attain these goals with anything less than 10 per cent growth, because the old model was not generating enough jobs per unit of output. As manufacturing moved up the value chain, firms increasingly replaced workers with machines embodying the latest technologies. As a result, its economic model spawned a labour-saving, capital-intensive growth dynamic.

On one level, that made sense. Capital-labour substitution is at the heart of modern productivity strategies for manufacturing-based economies. But it left China in a deepening hole: Increasingly deficient in jobs per unit of output, it needed more units of output to absorb its surplus labour.

Ultimately, that became more of a problem than a solution. The old manufacturing model, which fuelled an unprecedented 20-fold increase in per capita income relative to the early 1990s, also sowed the seeds of excessive resource consumption and environmental degradation.

Services-led growth is, in many ways, the antidote to the “unstable, unbalanced, uncoordinated, and ultimately unsustainable” growth model former Premier Wen Jiabao criticised in 2007. Yet, services offer more than just a labour-intensive growth path. Compared to manufacturing, they have much smaller resource and carbon footprints. A services-led model provides China with an alternative, environmentally friendlier and more sustainable economic structure.

IF REBALANCING FAILS

It is premature, of course, to conclude that a services-led transformation to slower growth is now at hand.

The latest data hint at such a possibility, with the tertiary sector (services) expanding at an 8.3 per cent annual rate in the first quarter — the third consecutive quarter of acceleration and a half-percentage point faster than the gain by the secondary sector (manufacturing and construction). But it will take more than a few quarters of mildly encouraging data to validate such an important shift in the economy’s underlying structure.

Not surprisingly, China sceptics are putting a different spin on the latest growth numbers. Fears of a shadow-bank-induced credit bubble now top the worry list, reinforcing concerns that China may succumb to the dreaded “middle-income trap” — a sustained growth slowdown that has ensnared most high-growth emerging economies at the juncture it has now reached. China is hardly immune to such a possibility. But it is unlikely to occur if China can carry out the services-led pro-consumption rebalancing that remains the core strategic initiative of its current (12th) Five-Year Plan.

Invariably, the middle-income trap afflicts those emerging economies that cling to early-stage development models for too long. For China, the risk will be highest if it sticks with the timeworn recipe of unbalanced manufacturing- and construction-led growth, which has created such serious sustainability problems.

If China fails to rebalance, weak external demand from a crisis-battered developed world will continue to hobble its export machine, forcing it to up the ante on a credit- and investment-led growth model — in effect, doubling down on resource-intensive and environmentally damaging growth. But I remain hopeful that China’s new leadership will move quickly to implement its new model. There are no viable alternatives.

HOW WILL THE WORLD COPE?

Financial markets, and growth-starved developed economies, are not thrilled with the natural rhythm of slower growth that a rebalanced Chinese economy is likely to experience.

Resource industries — indeed, resource-based economies like Australia, Canada, Brazil and Russia — have become addicted to China’s old strain of unsustainable hyper-growth. Yet, China knows it is time to break that dangerous habit. The United States is likely to have a different problem with consumer-led growth in China. After all, higher private consumption implies an end to China’s surplus savings — and to the seemingly open-ended recycling of that surplus into dollar-based assets such as US Treasury bills. Who will then fund America’s budget deficit and on what terms?

Just as China must embrace slower growth as a natural consequence of its rebalancing imperative, the rest of the world will need to figure out how to cope when it does. PROJECT SYNDICATE

Stephen S Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of The Next Asia.

STEPHEN S ROACH